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Thursday, January 10, 2008

Cruise Control at the ECB

By Claus Vistesen Copenhagen

This is really just an update relative to my post yesterday talking about today's ECB meeting. As expected, the decision amounted to a holding operation (Q&A here) but more interestingly was the fact that Trichet and his colleagues still seem stubbornly persistent on retaining what they denote as a tightening bias or more specifically they are reserving their real option to act upon inflation. The following from Trichet's introductory statement sums up today's message ...

To sum up, a cross-check of the outcome of the economic analysis with that of the monetary analysis fully confirms the assessment that there are upside risks to price stability over the medium term, in a context of very vigorous money and credit growth and sound economic fundamentals in the euro area. At the same time, the potential impact on the real economy of the ongoing reappraisal of risk in financial markets remains uncertain. Consequently, we will monitor very closely all developments. The Governing Council remains prepared to act pre-emptively so that second-round effects and upside risks to price stability do not materialise and, consequently, medium and long-term inflation expectations remain firmly anchored in line with price stability. Reflecting its mandate, such anchoring is of the highest priority to the Governing Council.

There are a few things to note here I think. The first thing is the simple question as to when the ECB's Governing Council will start to pay attention to events in the real world. Ok, full stop here! It is indeed true that inflation forms a part of this real world picture and it is also true that the mandate by which the council is put into being is anchored in the maintenance of price stability. However, another part of the story is then that we are now dealing with the prospect of a Eurozone wide slowdown which is becoming clearer by the day. So, we can all see the tradeoff and no-one is saying that it is going to be pretty either way. But there are two issues in particular which I think are missing in the general account. The first is the idea that the Eurozone is not excluded from the rest of the world. De-coupling à la traditionelle has been weighed and found wanting and the ECB's policy stance is a bet on de-coupling which just does not seem to fit with the fundamentals. Secondly, we have the inflation issue itself which I am sure anybody can agree is not to be treated lightly. However, I can't stop but feel that we are risking falling victim to tale about how it does little service to close the barn door and mend the fence once the horse has already evaded. In this way, it is a bold game to believe that you can wait until inflation has abated since then the horse will be thundering across your neighbour's meadows. In short, I see the ECB boxing itself in on this one and although cruise control can be a pleasant companion when the road is straight and the pavement smooth you need to put your foot on the clutch if you want to shift gears. Ok enough of my own personal sentiment here. What are the likely consequences of today's ECB (non)action?

In essence, it was not today that the ECB shifted its stance towards a more balanced look at the economy but when will it be then ... that is difficult to say. One thing is certain and that is that the longer we venture into 2008 the more implausible the ECB's 'vigiliance light' against inflation will sound. Coupled with the likely trajectory of the economic data and of course pending on the inflation readings I see a slight change at the next ECB meeting (although still a hold) which could pave the way for a cut at either the April or May session. As for the EUR/USD we now need to factor in that while Trichet has played his cards such as it is Bernanke is up next and this means that, contrary to what I noted yesterday (see first link in this post), we could see a sniff at 1.50. I maintain my view however that the fundamental bias for 2008 should be for a short EUR/USD position.

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Welcome to Global Economy Matters. Posts on Global Economy Matters are written by macro economists and policy analysts who have a common interest in global macro and economic policy.

Claus and Edward's "Baker's Dozen"

Claus Vistesen and Edward Hugh are proud and happy to announce that they are now working as "featured analysts" with a new Boston-based start-up - Emerginvest.

Claus and Edward have used a new, updated, methodology in order to identify a group of 13 emerging economies which we consider are going to outperform both the rest of the emerging economy group and the OECD economies in terms of a number of key performance indicators over the 2008 - 2020 horizon.

Through our association with Emerginvest we hope to develop performance indicators which will confirm both the relevance and validity of the selection procedure adopted.

We would like to point out that we have absolutely no financial connection whatsoever with Emerginvest - although we do heartily endorse what they are trying to do.

In particular we see the move by the investment community towards emerging markets as one of the most effective and direct ways to address those issues of inter-country wealth and income imbalances which have plagued our planet for so long now - namely by getting the money from the rich who have it to the poor who need it.

Sending investment to emerging economies is also a way of addressing the underlying imbalances which exist between the relatively older populations of the developed economies who increasingly need to save, and the relatively younger emerging economies who can benefit from the investment of those savings in their countries. So in a way you can both ensure the future of your own pension and help attack poverty at one and the same time. This type of possibility is normally known in economics as "win-win".

The oldest known source and most probable origin for the expression "baker's dozen" dates to the 13th century in one of the earliest English statutes, instituted during the reign of Henry III (r. 1216-1272), called the Assize of Bread and Ale. Bakers who were found to have shortchanged customers could be liable to severe punishment. To guard against the punishment of losing a hand to an axe, a baker would give 13 for the price of 12, to be certain of not being known as a cheat. Specifically, the practice of baking 13 items for an intended dozen was to prevent "short measure", on the basis that one of the 13 could be lost, eaten, burnt or ruined in some way, leaving the baker with the original dozen.